Saturday, March 23, 2013

Financial repression 101

That's exactly what Cristina Fernández de Kirchne's government has been doing for some time.

The Nation: - Among several reasons for these accusations could be the country’s current inflation rate (estimated by economists to be 26 percent, while the government cites it as 11.1 percent); the state’s assumption of control of private pension funds valued at 30 billion; the government’s restrictions on currency exchange, making it difficult for citizens to travel outside of Argentina; restricted freedom of speech; and, most significantly, an accusation of widespread corruption.

Argentina's actions don't just threaten the nation's democratic system. The latest policies amount to a harsh form of financial repression that will bring the nation's private sector to its knees. As confidence in Argentina's stability deteriorates, foreign reserves are becoming dangerously low. The latest move to close any loopholes that allowed outflows of dollars from the country is now impacting domestic market liquidity.

WSJ: - Argentina's stocks and bonds tumbled Friday, after the government announced new rules limiting mutual fund investments in the locally traded shares of foreign companies.

The regulations further restrict the ability of Argentines to invest offshore at a time when the Central Bank of Argentina is struggling to rebuild its international reserves due to capital outflows and low grain exports.

Starting April 30, the shares of foreign companies traded in Argentina, known as Cedears, will no longer be classified as local securities under rules that require mutual funds to invest no less than 75% of their assets in domestic securities.

"Cedears are going to have less liquidity, some mutual funds are going to have to unwind, and people are going to have to repatriate funds," said Agusto Farina, a trader at Buenos Aires-based brokerage Amirante Galitis.

Trading in Cedears hit 59 million pesos ($11.5 million) during the session. The turnover in Cedears since the beginning of the year through mid-March was about ARS360 million.

The new mutual fund rules appear to be aimed in part at businesses and sophisticated investors that use the securities market to legally skirt currency controls. The so called "blue-chip swap" transaction involves the purchase of stocks and bonds traded in Argentina, which are then sold offshore for dollars.

With currency controls shutting off hard currency outflows, the premium on dollars has reached new highs. According to JPMorgan, the dollar now trades in the "gray market" at some 70% above the official exchange rate. That's on top of the 26% decline in the peso's "official" value over the past couple of years.

Source: JPMorgan

Foreign investors are staying away. With inflation out of control and a limited ability to take earnings out of the country, investment in Argentina makes no sense. And capital looking for Latin American investments will find a much friendlier climate in Brazil or Mexico (as well as a number of smaller nations). By attempting to stem the flow of dollars out of the country with blunt policies, the government has cut off what the nation really needs - foreign investment.

JPMorgan: - Immediately after they were imposed, capital controls
probably had an expansionary impact on the economy owing
to the surge in domestic liquidity, bank intermediation, and
consumption spending that they triggered. However, that
stimulus represents a one-off and may be on the verge of
tapering off. Looking ahead, capital controls threaten to exert
an adverse toll on expectations of economic performance.
Paradoxically, if evidence that tightening capital controls
constrains inward investment continues to mount, the
government will find it increasingly hard to deliver on its
priority goal—economic growth.

Ironically, dollar outflows were caused in part by the government's earlier decision to confiscate private property of a large foreign investor (see post). Welcome to the world of financial repression and its "unintended consequences".